Factor Investing





Kerry Back

Factors

  • Factors are stock characteristics that predict returns
    • value (cheap relative to book, earnings, …)
    • momentum (high past return)
    • liquidity (high volume, low bid-ask spread, …)
    • volatility
    • quality (profitability, high cash flow to income, …)

Sorts on characteristics

  • Sort into quintiles or deciles
  • Equally weighted or value weighted return of each group
  • Re-sort at the beginning of the next period
  • French’s data library: monthly sorts and returns

Investing in multiple factors

  • How best to combine factors?
  • Could sort on factors separately and intersect sorts
    • Example: quintiles and 2 factors \(\Rightarrow\) 25 groups
    • Quintiles and 5 factors \(\Rightarrow\) 3,125 groups. Many will be empty.
  • Could form portfolio for each factor and equally weight
  • Could combine factors to predict returns and then sort on predictions

Industry examples



Factor investing at BlackRock


Factor investing at AQR